Published Jun 29, 2026 4 Min Read

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Introduction

Tracking difference and tracking error are two important measures used to evaluate index funds. Tracking difference shows the gap between the fund's return and its benchmark, while tracking error measures how consistently that gap changes over time.

  • Tracking difference compares the fund's return with the benchmark's return. 
  • Tracking error measures the consistency of return differences. 
  • Lower tracking difference and tracking error generally indicate closer benchmark tracking. 
  • You can invest through SIP or lumpsum, with SIPs starting from Rs. 100 per month on the Bajaj Broking website. 
  • Investors can choose from 4,000+ mutual fund schemes across equity, debt, hybrid, ELSS and thematic categories. 
  • Always review the SEBI-mandated riskometer before investing in any mutual fund. 

Start investing on the Bajaj Broking website after completing your KYC and choose from 4,000+ mutual fund schemes that suit your financial goals.

What is tracking difference?

Tracking difference is the difference between the return generated by an index fund and the return of its benchmark index over a specific period.

For example, if an index earns 12% during a year and the index fund delivers 11.7%, the tracking difference is 0.3 percentage points.

A smaller tracking difference generally indicates that the fund has closely matched the benchmark's performance.

Tracking difference reflects the impact of factors such as:

  • Expense ratio 
  • Cash holdings 
  • Fund expenses 
  • Portfolio rebalancing 
  • Dividend treatment 

Although index funds aim to replicate an index, it is normal for a small tracking difference to exist.

What is tracking error?

Tracking error measures how consistently an index fund follows its benchmark over time. Instead of showing the average difference in returns, it measures the variation in those differences.

A fund may have a small tracking difference but still have a high tracking error if its performance varies significantly from the benchmark during different periods.

In simple terms:

  • Tracking difference measures the average gap. 
  • Tracking error measures the consistency of that gap. 

Lower tracking error generally means the fund has tracked the benchmark more consistently.

Tracking difference vs Tracking error: Key differences

Although these two terms are often used together, they measure different aspects of an index fund's performance.

FeatureTracking DifferenceTracking Error
MeaningDifference between fund return and benchmark returnConsistency of the return difference over time
FocusAverage performance gapVariation in performance gap
MeasurementPercentage differenceStatistical measure of return variability
What it indicatesHow closely returns match the benchmarkHow consistently the benchmark is tracked
Lower valueGenerally preferredGenerally preferred

When evaluating an index fund, it is useful to consider both measures instead of relying on only one. A fund with a low tracking difference and low tracking error generally follows its benchmark more closely.

How are tracking difference and tracking error calculated?

Tracking difference and tracking error measure different aspects of an index fund's performance. Tracking difference compares returns, while tracking error measures how consistently the fund follows its benchmark.

MeasureHow it is calculatedWhat it tells you
Tracking differenceFund return − Benchmark return over a specific periodThe average gap between the fund and the benchmark
Tracking errorStatistical measurement of the variation in return differences over timeHow consistently the fund tracks its benchmark

For example, if an index delivers a return of 10% and the index fund delivers 9.8%, the tracking difference is 0.2 percentage points.

Tracking error is calculated using statistical methods based on the periodic differences between the fund's returns and the benchmark's returns. A lower tracking error generally indicates that the fund has tracked the benchmark more consistently.

When comparing index funds, consider both measures instead of relying on only one.

What causes tracking difference and tracking error?

Even though index funds aim to replicate a benchmark, they rarely match its returns exactly. Several factors can create differences between the fund and the index.

CauseImpact
Expense ratioFund management costs reduce overall returns because the expense ratio is deducted from the NAV by the AMC.
Cash holdingsFunds may hold cash to manage subscriptions, redemptions or expenses, which can affect returns.
Portfolio rebalancingChanges in the benchmark may take time to reflect in the fund's portfolio.
Corporate actionsDividends, mergers, bonus issues and stock splits may temporarily affect tracking.
Transaction costsBrokerage and other trading expenses can create small differences from the benchmark.
Market liquidityDifficulty buying or selling securities at the required price may affect fund performance.

Most index funds experience some tracking difference and tracking error. The objective is not to eliminate them completely but to keep them as low as reasonably possible.

Before investing in any index fund, review:

  • The expense ratio 
  • Historical tracking difference 
  • Historical tracking error 
  • The benchmark index 
  • The SEBI-mandated riskometer  
  • Your investment goals and risk appetite 

On the Bajaj Broking website, you can compare 4,000+ mutual fund schemes across equity, debt, hybrid, ELSS and thematic categories before making your investment decision.

Conclusion

Tracking difference and tracking error are important measures for evaluating an index fund's ability to follow its benchmark. Tracking difference shows the average gap between the fund's return and the benchmark's return, while tracking error measures how consistently the fund tracks the benchmark over time.

When selecting an index fund, look for both a low tracking difference and a low tracking error rather than focusing on only one measure. Also consider the expense ratio, benchmark index, fund objective and the SEBI-mandated riskometer before investing. Remember that all mutual fund investments are market-linked, and past performance does not guarantee future returns.

On the Bajaj Broking website, you can explore 4,000+ mutual fund schemes across equity, debt, hybrid, ELSS and thematic categories. After completing your mandatory KYC, you can invest through an SIP from Rs. 100 per month or make a lumpsum investment.

Frequently asked questions

What is the difference between tracking difference and tracking error?

Tracking difference and tracking error measure different aspects of an index fund's performance. Tracking difference shows the average difference between the fund's return and the benchmark's return over a specific period. Tracking error measures how consistently the fund follows the benchmark over time. A lower value for both generally indicates that the index fund is closely tracking its benchmark. On the Bajaj Broking website, you can compare index funds using these measures before investing.


What is a good tracking error for an index fund?

A lower tracking error is generally considered better because it indicates that the index fund is consistently following its benchmark. There is no single ideal number, as tracking error varies across fund categories and market conditions. When comparing index funds, review tracking error along with the expense ratio, tracking difference and the SEBI-mandated riskometer to make an informed investment decision.


Why does tracking difference occur?

Tracking difference occurs because an index fund incurs expenses and operational costs that the benchmark index does not. Factors such as the expense ratio, cash holdings, transaction costs, portfolio rebalancing and corporate actions can all create small differences between the fund's return and the benchmark's return. Since the expense ratio is deducted from the NAV by the AMC, a small tracking difference is normal in most index funds.


Does tracking error affect my actual returns?

Tracking error does not directly reduce your returns. Instead, it indicates how consistently an index fund tracks its benchmark over time. A high tracking error means the fund's performance may vary more from the benchmark during different periods. When selecting an index fund on the Bajaj Broking website, compare both tracking error and tracking difference along with the fund's investment objective.


Which is more important: tracking error or tracking difference?

Both measures are important because they provide different information. Tracking difference tells you how much the fund's return differs from the benchmark over a period, while tracking error shows how consistently the fund follows the benchmark. When comparing index funds, consider both measures together instead of relying on only one. This gives you a better understanding of how closely the fund replicates its benchmark.

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The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed.

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